The colour of money

By Anne Harris

Published Saturday, October 11, 2008

Renewable energy continues to flourish despite the bleak economy.

With the financial markets seemingly crumbling around our ears, it would appear to be an inopportune time for the renewable energy sector to begin its huge growth push to meet the UK government's testing 2020 targets. But the good news is that the green energy sector is one of the few that is forging ahead despite the current climate.

"The clean energy sector is one that is bucking the trend because there is so much demand for new solutions and new technologies in that space," Peter Linthwaite, managing partner at Carbon Trust Investment Partners, explains. "Companies that have good technologies and ideas in that space will be able to raise capital and continue to grow. Where the credit crunch may have an effect is on the large-scale project financing such as large offshore wind farms."

Recent weeks have seen US institutions Lehman Brothers and Merrill Lynch join the list of ailing financial houses, and it seems certain that there are more to follow as the financial freefall continues and the credit crunch tightens its steely grip.

Bucking the trend

Investment in renewable energy worldwide has been growing very strongly. It totalled $148.4bn in 2007, up no less than 60 per cent on the previous year, and nearly five times the level of 2004. The biggest single category of that investment is money going into renewable energy projects - wind farms, biofuel plants, solar parks, biomass generators, mini-hydro schemes, and the like. This totalled $84.5bn in 2007, compared to $50.3bn in 2006.

Wind is by far the biggest sector, accounting for $38bn of that $84.5bn. Solar was $18.3bn, biofuel projects $16.4bn (with Brazil very important in that), and biomass and waste-to-energy was $9.6bn.

Wave and tidal are very early stage and are attracting venture capital money, but the early projects are very small compared to those in wind.

As to why the green sector is continuing to attract investment, Linthwaite feels it is because the sector is so important, on several levels. "It is important not just because it makes you feel better from a moral standpoint, but it's important with oil prices rising - most companies are recognising that the days of cheap oil are over - there is a need for energy efficiency," he says. "Better, more efficient ways, of managing the processes and operations that use less energy is vitally important.

"As the whole investment climate gets tougher it could have an affect, but, that said, because it is a sector that is growing anyway due to the demand for clean energy business it is probably a sector that people will still want to invest in. As other sectors of the economy, such as leisure, that have had a lot of investment in recent years slow down because the consumer are not buying much, what may happen is that people seeing there is still a lot of demand for energy efficiency and green energy and that will attract more investment."

Tough times call for tough measures, and when companies feel the squeeze on their bottom lines they look at ways of cutting costs. There is little doubt that with escalating energy prices, reducing the amount of energy consumed is an important factor.

The Carbon Trust, along with other venture capital companies, specialise in funding early technology development. "Smaller, newer companies are one of the characteristics of the cleantech arena," Linthwaite adds. "There is a lot of innovation, a lot of new ideas and a lot of young companies that are entering the market.

"They are usually companies looking for investment rather than debt. So they want to raise equity capital rather than borrow money from the banks because, in many cases, they are still at an early stage of their development and banks would not want to lend to them.

"The important differential is between banks that lend money and want it back with interest, and venture capital firms, that look to invest in companies for the long-term and look at an equity return. If the company does well we do well.

"Equity tends to be long-term as you can't demand your money back once you have invested. You can sell your shares but the company will still keep the initial investment. Typically you are looking at an exit route of five years."

Not all rosy

Despite those who preach business as normal, there is bound to be some fallout, even for such a vibrant sector as green energy.

"The credit squeeze is affecting the sector this year," says Angus McCrone, chief editor, at New Energy Finance. "Banks are charging around 25 basis points more in their spreads over Libor or Euribor for wind farm debt, and they are insisting on rather more conservative structures - with more equity and a bit less debt than in 2007.

"Biofuel project financing in Europe and North America has got a lot more difficult, but this is largely because of that sector's problems with high feedstock costs and competition from low-cost imports. The downturn in the stock market has made it more difficult for renewable energy firms to raise money from public markets, although there is still a lot of venture capital and private equity money around for young companies."

Rabobank green energy executive Tanja Cuppen told an industry conference this week the credit crunch will have a major impact on renewable energy, and the worst is still to come. The European renewable energy sector would see loan finance availability reduced by €21bn ($US30bn) up to 2020. This compares to estimates that the sector needs €85bn worth of investment in wind, solar and other forms of zero-emissions power over that time to meet the EU's target for 20 per cent of electricity to be generated from green sources by 2020.

"This could mean that the fast growth in renewable energy assets will be delayed," Cuppen adds. "Most financing of renewable energy projects is currently taken on by banks and energy companies. But Rabobank would like to interest other financial institutions, such as pension funds and insurance companies, to also invest in renewable energy assets - their more active presence in the market would lessen the capital shortage."

Linthwaite concurs with those sentiments, but feels it is only the very large projects that will suffer. "With very large project financing, such as major offshore wind farms, there may be issues around arranging the debt finance as there would be for any large-scale project, but for the majority of the industry I think you are looking at a sector that is still very much alive and kicking."

Debt or equity

Dr Jim Fitzgerald, associate director at Ernst & Young, draws an important distinction between the equity finance that traditionally comes from venture capital companies and used for early technology development against the debt funding usually used for deployment.

"The important thing is that there is still money, but not where we are used to getting it from," he explains. "What we are seeing in the market is debt funding has decreased, the ability of investors to inject money into projects and the appetite they have for the amount of risk has decreased.

"That is not to say that they have exited completely, we are still seeing some deals being completed, but increasingly we are going to see that money replaced by equity and also new investors types - institution types and longer-term money linked to longer-term investment horizons coming in to bridge the gap between equity and debt financers.

"The early stage VC funding, although important for the new technologies to come through, is not really the huge amount of money needed in that sector. So the big things are the multi-billion pounds needed to finance the offshore wind farms, which have never been the VC's markets. So the biggest harm from the credit crunch may come in slowing the roll out of these big projects."

Fitzgerald explains that, in his experience, deals have slowed and some projects will not proceed. He stresses that debt finance is still available, but only for well-structured projects that have managed to de-risk themselves, both technologically and in terms of market economics.

"So the best projects will still get financing and access to debt to enable their projects to proceed," he concludes.

Another option, and one that is increasingly being adopted, is for the large utilities to take up quite a bit of the slack and invest their own money in large projects - funds that they have raised through other mechanisms.